"Be careful what you wish for," the old saying goes, and so too for those who wished for Chrysler to file for bankruptcy in order to achieve their objectives. Chrysler and all its major constituents will argue that the house is on fire and absent a quick sale on the agreed-upon terms (well summarized in this Treasury release), asset values (whatever’s left of them) will be irrevocably destroyed. The dissident lenders will argue that the fire is an ingenious illusion meant to force them to accept a deal that denies them their first priority rights to Chrysler’s assets and is merely a disguised plan of reorganization that a Court has no authority to approve in the 363 sale context.
So what’s the risk for the proponents of the sale? As Chrysler’s own counsel at Jones Day wrote in this 2002 publication:
[U]nder certain circumstances a debtor may sell all or substantially all of its assets without making the sale part of a plan of reorganization. Where a chapter 11 debtor proposes to sell its assets or business "outside of a plan of reorganization," creditors are entitled to notice of the sale and an opportunity to voice any objections they may have with the court. However, the sale will not be subject to the same creditor disclosure and voting rights attendant to a sale as part of a plan of reorganization. Moreover, the proposed sale will be subject to the less exacting "business judgment" standard of review. For this reason, some courts refuse to approve a proposed sale outside of a plan of reorganization if it appears that the transaction is really a "sub rosa" or "de facto" plan because the terms of the sale will necessarily dictate the provisions of any future plan.
You don’t have to be a bankruptcy maven to see from the face of the term sheet that the proposed sale dictates the provisions of a future plan of reorganization and sure has the feel of a "sub rosa" or "de facto" plan under which:
- Lenders with a first priority interest in Chrysler’s assets will receive $2 billion, nothing more.
- The junior VEBA claimants will receive a $4.6 billion note payable over 13 years at a 9% rate of interest and additionally will receive 55% of the equity of New Chrysler.
- Unsecured trade payables of about $1.5 billion get paid in full.
- The US Treasury will receive 8% of the equity of New Chrysler as repayment of its $4 billion junior TARP loan while the Canadian government gets a 2% stake for its junior loans.
What’s the governing law? Well, since the case was filed in New York, the law of the Second Circuit Court of Appeals applies. The latest pronouncement from the Second Circuit on whether 363 sales are disguised "sub rosa" plans came in Motorola, Inc. v. Official Comm. of Unsecured Creditors, 478 F.3d 452 (2007), where the Court wrote:
The trustee is prohibited from such use, sale or lease if it would amount to a "sub rosa" plan of reorganization. The reason "sub rosa" plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, “short circuit the requirements of [C]hapter 11 for confirmation of a reorganization plan.” Pension Benefit Guar. Corp. v. Braniff Airways, Inc. (In re Braniff Airways, Inc.), 700 F.2d 935, 940 (5th Cir. 1983). In this Circuit, the sale of an asset of the estate under § 363(b) is permissible if the “judge determining [the] § 363(b) application expressly find[s] from the evidence presented before [him or her] at the hearing [that there is] a good business reason to grant such an application.” Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983).
The Court noted in a footnote a "number of factors that a judge might consider when determining whether there is a ‘business justification’ for the asset’s sale." These factors include, but are not limited to, the following:
- the proportionate value of the asset to the estate as a whole;
- the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future;
- the effect of the proposed disposition on future plans of reorganization;
- the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property; and
- "most importantly perhaps," whether the asset is increasing or decreasing in value.
The best recent case I’ve seen analyzing whether a 363 sale is a disguised "sub rosa" plan is an unreported decision from Houston’s fiery Judge Wesley W. Steen in In re Gulf Coast Oil Corp., 2009 WL 361741 (Bankr. S.D. Tex. 2/11/09) (pdf). Judge Steen methodically reviews case law, articles, treatises, and even this story from the WSJ Bankruptcy Beat Blog, in drawing the following conclusion:
"It would be very helpful if the Fifth Circuit were to take another look at the boundaries of § 363(b) sales to provide more guidance to the bankruptcy courts in the circuit. Under the existing jurisprudence;
- The debtor in possession or trustee in a chapter 11 case must consider its fiduciary duties to all creditors and interest holders before seeking approval of a transaction under § 363(b).
- The movant must establish a business justification for the transaction and the bankruptcy court must conclude, from the evidence, that the movant satisfied its fiduciary obligations and established a valid business justification.
- A sale, use, or lease of property under § 363(b) is not per se prohibited even though it purports to sell all, or virtually all, of the property of the estate, but such sales (or proposed sales of the crown jewel assets of the estate) are subject to special scrutiny.
- Parties that oppose § 363(b) transactions on the basis that they constitute a sub rosa chapter 11 plan must articulate the specific rights that they contend are denied by the transaction.
- Although the bankruptcy court need not turn every § 363(b) hearing into a mini-confirmation hearing, the bankruptcy court must not authorize a § 363(b) transaction if the transaction would effectively evade the “carefully crafted scheme” of the chapter 11 plan confirmation process, such as by denying §§ 1125, 1126, 1129(a)(7), and 1129(b)(2) rights.
- If the bankruptcy court concludes that such rights are denied, then the bankruptcy court can only approve the transaction if it fashions an appropriate protective measure modeled on those which would attend a reorganization plan.
- Transactions that explicitly release all (or virtually all) claims against the estate, predetermine the structure of a plan of reorganization, and explicitly obligate parties to vote for or against a plan are not authorized under § 363(b)."
Judge Steen’s analysis provides a wonderful guide on how to analyze the strength of Chrysler’s position. In concluding that the debtor in that case did not meet its burden of establishing that the assets of the debtor should be sold outside of the context of a reorganization plan, he asks:
- Is there evidence of a need for speed?
- What is the business justification?
- Is the case sufficiently mature to assure due process?
- Is the proposed APA sufficiently straightforward to facilitate competitive bids or is the purchaser the only potential interested party?
- Have the assets been aggressively marketed in an active market?
- Are the fiduciaries that control the debtor truly disinterested?
- Does the proposed sale include all of a debtor’s assets and does it include the "crown jewel" (noting that "the likelihood of approval of the § 363 sale is inversely proportional to the percentage of the value of the debtor’s assets that are to be sold")?
- What extraordinary protections does the purchaser want?
- How burdensome would it be to propose the sale as part of confirmation of a chapter 11 plan?
- Who will benefit from the sale?
- Are special adequate protection measures necessary and possible?
- Was the hearing a true adversary presentation? Is the integrity of the bankruptcy process protected?
- What other factors apply to the case at hand that tip the balance or that overweigh the evaluative factors set forth above?
Looking at the pleadings filed thus far in the Chrysler case, Chrysler’s CFO lays out the business justifications for the sale at pages 38-41 of this affidavit in support of the first day pleadings. In the end, however, the matter will be determined by the opinion testimony elicited from the parties’ opposing experts (with Houlihan Lokey’s Eric Siegert representing the dissenting lenders and Capstone Advisory Group’s Robert Manzo, who prepared this 166 page first day affidavit / expert report, representing Chrysler). Notably, Manzo concludes in his affidavit (pp. 26-27) that:
Based on the Liquidation Analysis, the First Lien holders are expected to recover between 9% and 38% of their claims, on a net present value basis, [which] translates into a range of between $654 million and $2.6 billion. It is my professional opinion that given the market developments subsequent to this analysis, coupled with the limited success of other OEM effort to move individual car lines, the First Lien holders would likely recover at the low end of this range as part of any liquidation of the Company. The U.S. Treasury is only expected to recover between 3% and 6% of its claims.
In effect, Chrysler is arguing that the Court should not be concerned that other junior creditors are receiving value while senior lenders are not paid in full because absent such payment to the other constituent groups, Chrysler would be forced to liquidate and the senior lenders would do worse than they will under the proposed alliance with Fiat. An additional supporting affidavit on the need to consummate the transaction with Fiat and the marketing efforts undertaken to sell Chysler was submitted by Tommy LaSorda (no relation to this guy), Vice Chairman and President of the Board of Managers for Chrysler.
Finally, never forget that in litigation, nothing is guaranteed. Indeed, much depends on the judge drawn. The judge overseeing this case is Judge Arthur Gonzalez, who proved here in the Enron case that he will adhere to what he believes the law requires, even if the financial markets turn upside down because of it.
So, who will win? Really, only the true speculator and/or holder of Chrysler credit default swaps will (and perhaps Fiat if they–unlike their predecessors–can make it work), as my first post on the financial carnage at Chrysler demonstrates. My guess is that after much briefing, discovery, and expedited litigation over the next 60 days, Judge Gonzalez will show enough angst to worry both sides that they stand to lose, thus resulting in a compromise that settles the matter and allows the transaction to go forward. But with all Chrysler plants and operations now idled pending a final sale, the pressure to get the deal consummated and return people to work will be so overwhelming that it’s hard to imagine Judge Gonzalez not approving the transaction in some form that’s acceptable to everyone (except perhaps the dissenting lenders).
© Steve Jakubowski 2009
5/1/09 Update: Special thanks to the following sites, some new, some favorites, who linked to this post:
Calculated Risk, Volokh Conspiracy, The Wall Street Journal, Truth About Cars, Daily Bankruptcy News (the best daily collection of links to bankruptcy-related stories around), ABI Blog Exchange, Simoleon Sense, i-Stock Analyst, Fear and Greed, Underbelly.